Hydro One upgraded to “Buy” at Industrial Alliance

Having gotten beat up over the past month, it’s time to put Hydro One (Hydro One Stock Quote, Chart, News, Analysts, Financials TSX:H) back in the game, says Elias Foscolos, analyst for Industrial Alliance Capital Markets, who reviewed the company’s latest quarter in an update to clients on Wednesday.

Electric transmission and distribution company Hydro One announced its fourth quarter 2020 financials on Wednesday, showing revenue up to $1.867 billion versus $1.715 billion a year earlier and EPS of $0.27 per share compared to $0.35 a year earlier. For the full 2020 year, Hydro One’s revenue went from $6.480 billion in 2019 to $7.290 billion, while adjusted EPS went from $1.54 per share in 2019 to $1.51 per share in 2020.

The company said the Q4 year-over-year drop in EPS was due to higher COVID-19-related costs from bad debt expense, a reduction in insurance proceeds, higher depreciation and asset removal costs related to growth in capital assets and timing of work and, finally, higher taxes.

Hydro one said its annual productivity savings of $286 million represented a 41.4-per-cent year-over-year increase, while infrastructure investments over the fourth quarter came in at $577 million

“Looking ahead, it is very difficult to determine or estimate the exact impacts of COVID-19 on Hydro One’s operations as it will be largely dependent on the duration of the pandemic and severity of the measures implemented to combat this virus. Hydro One continues to take the necessary steps to mitigate the impact of COVID-19 on the Company’s operations,” the company said in a press release.

Hydro One’s share price had been on the upswing for a number of years, rising from $19.00 in 2018 to as high as $30.00 over the last few months. But the stock has dropped off considerably since the start of February, losing about 11 per cent over the month.

That pullback has factored into Foscolos’ new call on Hydro One, as the analyst has raised his rating from “Hold” to “Buy” with an unchanged 12-month target of $31.00. At press time, that would represent a projected return of 20 per cent including dividend.

In his report, Foscolos noted that Hydro One’s fourth quarter adjusted EPS of $0.27 per share was under his forecast for $0.29 per share and the same from the Street. The analyst said income tax expenses were higher than he expected but looking ahead that effective tax rate should be within the company’s guidance of between six and 13 per cent.

“In the staff proposal from the Ontario Energy Board (OEB) regarding recovery of costs related to COVID-19, the OEB is proposing that recovery be subject to a means test, translating into a lower probability of cost recovery for H. As a conservative measure, H expensed bad debt in the quarter that had been previously recorded as a regulatory asset. In our view, this eliminates earnings downside, but upside is likely limited as well,” Foscolos wrote.

Foscolos said Hydro One now has stable and predictable Transmission and Distribution rates through 2022 which should allow the company to absorb near-term inflation and interest rate risk in the return on equity.

“Hydro One’s Q4/20 EPS of $0.27 was a bit below forecasts, but this does not impact our outlook. The company continues to guide about a five per cent rate base and dividend growth annually, and five and seven per cent normalized EPS growth from 2019-2022,” Foscolos wrote.

“With H’s Transmission and Distribution rate framework established through 2022, the Company is insulated from potential near-term volatility in inflation and interest rates. Key events to watch for this year will be: (a) resolution of the deferred tax asset, and (b) the T&D joint rate application for 2023-2027. Based on H’s favourable outlook and factoring in current share price weakness, we are upgrading our rating to Buy (previously Hold),” Foscolos said.

The analyst has adjusted his estimates for Hydro One and is now calling for 2021 adjusted EBITDA of $2.530 billion (previously $2.459 billion) and EPS of $1.52 per share (no change) and for 2022 adjusted EBITDA of $2.630 billion (previously $2.556 billion) and EPS of $1.60 per share (no change).

Foscolos’ target price is based on a combination of an 18x multiple of his 2021 P/E estimates, a 12x multiple of his 2021 EV/EBITDA estimates and a dividend discount model.

In his comments on the quarterly numbers, Hydro One president and CEO Mark Poweska said the company is committed to keep customers facing hardship related to the pandemic connected to power and working with customers to access financial programs to help get their accounts back in good standing.

“During a year that challenged us all, we remained guided by our corporate strategy as well as our commitment to protect employees and support customers and communities,” said Poweska in a press release. “As we look to the future, we have an important role in rebuilding the economy and helping people and small businesses emerge from this crisis.”